WEAKNESSES

Risk assessment

Azerbaijan's growth might experience in 2016 its first recession in twenty years

Growth, hit by lower oil prices, is expected to be negative in 2016. The hydrocarbon sector (40% of GDP), especially the gas sector, will continue to dominate the economy. Gas production should increase strongly, thanks to the launch of the second stage of the Shah Deniz project, although gas deliveries are not expected before 2018-2019. Activity in services (30% of GDP) and construction, sustained by public investment in recent years, may decline due to a more restrictive fiscal policy.

Consumption is not likely to be much more dynamic in 2016 than in 2015, given a fiscal policy which is set to be only modestly expansionary and a high inflation rate.

Furthermore, persistence of low hydrocarbon prices and high interest rates (raised from 5% to 7% in March 2016) would weigh on investments (except in infrastructure projects already launched and supported by the State, like pipelines construction). Finally, export contribution may be limited by slow production increase and hydrocarbon price lower in 2016 than in 2015.

Consumer price rises are set to continue, fuelled by the ongoing impact of the depreciation of the manat against the dollar observed in 2015.

Worsening public deficit but stabilisation of the current account

Despite the fiscal consolidation effort announced in 2015, the government would not be able to forgo an increase in social spending, even moderate, in order to limit the decline in real incomes. However, the prioritising of public investment projects could be revised. The cut in spending may be not sufficient to offset the higher than expected drop in oil and gas income (50% of State revenues). Moreover, non-hydrocarbon revenues might be severely hit by the decrease in activity. In this context, the government amended its budget project in February 2016, now based on an oil price of 25 $/bl (conservative assumption).

The amount of assets accumulated in the sovereign fund SOFAZ, estimated at nearly USD 34 billion (over 50% of GDP) as the end of 2015, gives the State comfortable room for manoeuvre.

After the sharp worsening observed in 2015, the external accounts are expected to stabilise in 2016. The devaluations in 2015 allowed Azerbaijan to recover a degree of competitiveness against Russian products whose prices have fallen steeply following the collapse of the rouble. However, exports, highly reliant on hydrocarbons (95% of the total), are unlikely to grow much due to low oil and gas prices and with production unlikely to increase strongly in the short term. Imports are expected to increase weakly, due to the moderation in demand and in public investment. FDI flows will remain considerable, especially for projects in the hydrocarbons sector (Trans-Anatolian and Trans-Adriatic pipelines –TANAP and TAP).

The central bank (BCA) abandoned the peg of the manat to the dollar at the end of 2015 after the currency loss about 50% against USD. The managed floating exchange arrangement introduced since then is devised to mitigate the impact of persistent low oil prices on budget revenues and preserve foreign currency reserves. The manat exchange rate strengthened in early 2016 and may stabilise with the assumption oil price would not slump again strongly.

The banking sector, highly dollarised, has been hit by the depreciation, which has weakened balance sheets.

Political stability, which does not exclude social tensions

President Ilham Aliyev, in power since 2003, was re-elected for a third term in October 2013. His party (New Azerbaijan Party - NAP) won the November 2015 parliamentary elections, boycotted by most of the opposition parties.

While the government has managed to maintain a degree of social and political stability to date, thanks to significant oil resources, growing inequalities and the strong economic slowdown are heightening popular discontent. The risks of repression and the weakness of the opposition are, however, limiting any protests.

Meanwhile, despite some progress, performance on governance remains less good overall than that of the other CIS countries, especially regarding the fight against corruption (ranked 172nd in 2014 while Russia is in 168th place and Kazakhstan 155th).

Finally, the risk of regional political instability remains high due to tensions with Armenia over the status of Nagorno-Karabakh, as evidenced by the resumption of fighting early April 2016. No scenario for resolving the conflict seems to be in sight, in the short term.